Noah Berger/Getty Images Entertainment

Noah Berger/Getty Images Entertainment

There are two things I generally dislike people quoting out of context; Bible verses and Warren Buffett quotes. Both are often cherry-picked to support a concept which may differ dramatically from their original use or meaning. In the case of our investment savior, Mr. Buffett, his words are often used out context to peddle an investment idea.

I've seen this a lot lately for what are purported to be good stocks for inflation. But what did Buffett actually say about this? Turn to the 1983 Berkshire Hathaway (BRK.A) (BRK.B) shareholder letter. As you probably know, the start of that decade was marked with double-digit inflation. Then, as now, it was at the forefront of investors' minds.

You can read the letter yourself, but in summary, he goes through the math of a business with lots of intangible assets, See's Candies, and compares it to a tangible asset-heavy business. The takeaway is that asset-light businesses like See's Candies are what do best during inflation.

"And that fact, of course, has been hard for many people to grasp. For years the traditional wisdom - long on tradition, short on wisdom - held that inflation protection was best provided by businesses laden with natural resources, plants and machinery, or other tangible assets ("In Goods We Trust"). It doesn't work that way. Asset-heavy businesses generally earn low rates of return - rates that often barely provide enough capital to fund the inflationary needs of the existing business, with nothing left over for real growth, for distribution to owners, or for acquisition of new businesses.

In contrast, a disproportionate number of the great business fortunes built up during the inflationary years arose from ownership of operations that combined intangibles of lasting value with relatively minor requirements for tangible assets."

That brings me to Amazon Web Services, better known as AWS. Yes, I'm doing exactly what I despise; likening a Buffett concept to a stock, Amazon.com, Inc. (NASDAQ:AMZN ).

As I've touched on in earlier pieces, Amazon retail, Prime Video, advertising, and their other bets are of minimal interest to me, at least from an investment perspective. If you were to value Amazon based on retail, it is a bubble. Why should it trade at 2-4x sales when Walmart (WMT) has averaged 0.54x during the last 10 years?

But Amazon is not a bubble. In fact, it is a deep value play. For starters, keep in mind that during the dot-com bubble it peaked at 25-35x sales which of course, is a far cry from today. Whether we're talking Walmart or Amazon, the reason the price/sales deserves to be low is because retail is a low-margin business. It's an asset-heavy business due to stores/warehouses and logistics, and there is lots of human labor needed.

Contrast that to software and similar asset-light business models. You can increase the prices of these services without a corresponding increase of input costs.

Sure, the pay of programmers will go up with inflation, but you've already paid them for the heavy lifting of building the moat (the software). Now you just need them for iterations. Of course, they're still vital, but their talent needed is more comparable to, say, hiring a plumber or painter to do maintenance on your house. You don't need to pay them to build your entire house because that was done previously.

Furthermore, your input cost for adding new customers is trivial, relative to an asset-heavy business. If you are an oil refiner already operating near full capacity and want to double your output, you need to build or buy double of everything. You must build out a new facility or expand your existing. You will need to double your workforce.

On the other hand, if you're AWS, to take on a new cloud customer, you're literally copying-and-pasting your pre-built code. Yes, there is server hardware, electricity costs, etc. but these are a small piece of the pie for this high margin business.

Since Amazon has practically no long-term net debt (relative to the size of the company), the enterprise value and market cap are fairly comparable. If it seems like I use them interchangeably, that's why.

At $125/share, the current market cap is $1.27T.

During its most recent quarter, total revenue was $116.44B. AWS was only 16% of that at $18.44B. A small slice of the pie but a big part of earnings; operating income of $6.52 billion. That's a 35% profit margin. Contrast that to retail, which typically carries a mid to high-single-digit percentage (at best).

Granted, that juicy 35% margin on AWS is a couple of percent higher than the recent average, but it's not an outlier. Before Amazon started breaking out the AWS segment in their reporting, UBS estimated the margin ranged from 47-53% during its first 8 years of operation.

While some build-out DCFs projecting AWS revenue over the next several years or through 2030, I feel that's far too presumptuous for a high-growth business. A lot can change, for better or worse, between now and then. DCFs are like a comfort blanket, a false sense of security. They're just guesses on top of guesses. You can paint whatever picture you want with them.

Let's be more conservative and just focus on the next 2-3 years.

This year, AWS should top $80B and next year, $100B. That actually assumes a slowdown in growth to "only" 25%. Much lower than the 37% growth we saw during the most recent quarter, or all the recent quarters and years of 30+ percent. If we assume another 25% y/y after that, it takes us to $125B for 2024.

Let's not go with the 35% profit margin on that. Let's stick with 33%. That equates to 41.25B in operating income for AWS in 2024.

If you slap a 25x multiple on that, it takes us to a market cap of $1.03T. Remember, today's market cap is just $1.27T. If you project out another year of growth and this time, let's take it down to only 20%, that means that by 2025, today's market cap would equal a 25x multiple on AWS alone.

Yes, that's a high multiple, but not out of place - even during today's tech wreck - for a high growth, high margin blue chip business. Just look at Microsoft (MSFT) for a comparative valuation.

In other words, you can buy AWS today and within a couple of years, it will be like getting the retail and everything else for free.

Yes, there may be dilution for stock-based compensation, but based on history, it should be trivial. Perhaps there will be none now that they're doing buybacks.

For those who say Amazon's growth days are over, keep in mind that the current CEO - Andy Jassy - was the former head of AWS. He's a 20-year veteran of the company.

His pay package of $212M may sound excessive until you realize his salary is only $175k. That $212M is stock-based compensation (61k shares pre-split) and it vests over a decade, between 2023 and 2031.

In other words, valued at about $21M a year, based on the then higher stock price. However, more than 80% of that doesn't vest until years 5 through 10. As such, he's more motivated than anybody to bring massive growth throughout this decade, too. Given his track record creating and building AWS, I'm betting he will deliver.

This article was written by

Disclosure: I/we have a beneficial long position in the shares of AMZN, BRK.B, WMT either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am not a financial advisor. This article is general information and for entertainment purposes only. It should not be misconstrued as being investment advice. Please do you own due diligence regarding any security directly or indirectly mentioned in this article. You should also seek advice from a financial advisor before making any investment decisions.